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Production sharing agreements versus concession contracts

By Julie Ing


Governments choose among many contracts to delegate the exploration and the extraction of oil. The contractual form changes between and within countries but the most common contracts are concession contracts and production sharing agree-ment (PSA). This paper compares the tax revenue and the firm’s incentive to explore and extract under these two contracts. We also investigate the effect of information asymmetry on costs on the optimal contract. The concession contract is simplified to a royalty rate and the PSA to a two-variable contract, i.e., the share of the ex-traction allocated to the costs reimbursement and the one the firm receives after this reimbursement. We show that without information asymmetry, PSAs always generate higher tax revenue than concession contracts. A large share of the extraction should be allocated to the cost reimbursement to promote the exploration and to avoid any productive distortions. In fact, under PSA, the government is able to capture almost the entire revenue. However, if the government does not know the firm’s costs, the government only captures a small share of the revenue under PSAs since the cost recovery mechanism increases the firm’s incentive to overvalue its costs. Under a con-cession contract, only one unique contract, independent from the firm’s efficiency, can be implemented.

Year: 2014
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